Company Notes Digest 11.4.16

Each week we read dozens of transcripts from earnings calls and presentations as part of our investment process. Below is a weekly post which contains some of the most important quotes about the economy and industry trends from those transcripts. Click here to receive these posts weekly via email.

By the time we write next week’s post, we’ll finally know who is the next President of the United States. Leading up to the election, the economy is quiet but stable. The race is close enough that it’s tough to know who is going to win, and it’s even harder to know what that person is going to do once in office. However, the path of the next four years will depend in large part on what happens Tuesday. The trends that we’re seeing below may change significantly.

I know that there’s a large contingent of investors who believe that the President doesn’t matter to markets, but if you study history, you know that nothing could be further from the truth. Almost all the significant turning points in market history have coincided with policy changes that were actively or passively set by POTUS. There’s a reason that the Great Depression bottomed in 1933 when FDR called a banking holiday, that the bull market of the 50s took off when business-friendly Eisenhower took office and that the 60s bull ended in 1969 when Nixon came into office with a “gameplan” to tighten monetary conditions. The President sets the course of the US economy.

The Macro Outlook:

The environment has stayed slow and steady

“Our perspective of the economy remains largely unchanged since last quarter…the U.S. is on a steady growth path with consumer confidence, unemployment, and wages holding firm. Of course, unless something unforeseen our growth coming out of the upcoming elections, but basically the U.S. had a steady growth path.” —Mastercard (Payments)

The economy is fully healed even if it’s not setting new records

“We are in a fully healthy environment for the type of services we are delivering. Even if it’s not a record year from volumes in most markets around the globe, it is still on a very high level” —Jones Lang LaSalle (Commercial Broker)

Conditions are still pretty difficult for industrial companies, but turning up

“As you may have noticed, MBI readings have ticked up over the past two months posting over 48 for both August and September. While these levels still denote contraction in metalworking end markets, the readings are nonetheless a significant improvement over the trends of the past year. If they sustain, it would bode well for our future prospects and indicate a potential leveling in the metalworking industry. That said, for now we remain cautious.” —MSC Industrial Direct (Industrial Distributor)

Still, there’s a pervasive sense of uncertainty

“we do think the thematic message that cuts through all these conversations is uncertainty, and if you think about any person running a business today and making a long-term capital commitment in the face of an economic environment and a presidential election that’s been as noisy as this one with as much uncertainty around the environment that we’re going to be dealing in, it’s, while disappointing, a little bit understandable that companies are basically pausing and waiting to see how things play out before they make a decision around major capital multi-year commitments.”–Eaton (Industrial)

CEOs are waiting to see what happens in the election

“from many of our customers, we’re hearing wait-and-see and that’s pretty typical in an election year. I mean, that’s the one new thing I’d call out over the last quarter and it’s typical that it builds as you get close to November. So, I don’t make much of it either way. I don’t think any of our customers have a sense of what it’s going to mean for after. The only thing I think it means is that, we always say our visibility is low, it’s probably even a bit lower just because of the cautious perspective that many of our customers have.” —MSC Industrial Direct (Industrial Distributor)

Companies are setting strategic plans that assume weakness

“broadly speaking, our view is that markets…continue to be weak and while we may see some bottoming, we don’t have an instigator for a significant growth directly in front of us. So our view is, given that we get in this for a couple of years now, the right posture for the company to take is to assume relatively weak markets, set our cost structure accordingly, find opportunities for cost savings, productivity gains, and then continuing to invest in those opportunities where we think markets could improve and we will be able to gain share and gain business accordingly” —Cummins (Truck Engines)

The consumer has been slowing

“I think some of the industries that we do participate in where I think folks would generally say there’s weakness, definitely retail. And retail is tough these days, brick and mortar retail, in particular with just changes in the way consumers and buying patterns are working in terms of online retail. Restaurants inevitably I think see the weak consumer, if the consumer is slowing down, which I think consensus is they are. You’re seeing a little bit of weakness there.” —Ares Capital (Business Development co)

But energy and currency are moving from a headwind to a tailwind

“FX is easing. So in our first quarter, FX was a 14% headwind, and it’s roughly a 1% headwind in Q4…I think the story on Energy is it’s been a dramatic headwind for us…We’re now starting to enter a period where…it’s going to quickly move from a headwind to a tailwind…If you don’t believe oil is going to decline further from here, all it does is stabilize. I think it’s accretive. If it happens to start picking up, it’s going to be more accretive as we go forward” —Ecolab (Business Services)

Inventories are much leaner than they have been

“the steel buyers, particularly the service centers, have decided to keep their inventories dangerously low… I see a lot of service centers working with inventories below two months…you can’t operate a service center business with inventories that low. Service centers are in the business of carrying inventory. If they don’t want to carry inventory, they’re in the wrong business…So don’t get distracted by this temporary weakness in prices in the US domestic market because these service centers that are working with less than three months of inventory, two months of inventory on hand, they will have to restock ” —Cliff’s Natural Resources (Iron Ore)

And pricing pressures are building

“I fundamentally believe right now we are about as close as we’ve been for a while relative to this price cost pressures…our price-cost ratio pressures are going to build…I’ve told people at the Fed this same issue. There is inflation brewing…material deflation is slowing down if not starting to come up…in order to hold our margins…next year, we’re going to have to come up with more stronger discretionary cost savings because I think price-cost will be working against us. That’s my call. I’m sure you’ve not heard that from anybody, but that’s my call” —Emerson Electric (Industrial)

International:

Capital flows to the US could reverse at some point

“Among the risks is the chance that the market is leaning the wrong way by assuming capital flows into U.S. assets will remain strong. Those flows could reverse, of course, if central banks outside the U.S. begin tapering asset purchases or, in other ways, start trimming their monetary stimulus.” —Oaktree (Asset Management)

A weaker pound should spark UK inflation

“Largely as a result of the depreciation of sterling, CPI inflation is expected to be higher throughout the three-year forecast period than in the Committee’s August projections. In the central projection, inflation rises from its current level of 1% to around 2¾% in 2018” —Bank of England (Central Bank)

“The depreciation of the British pound has had a negative impact, although the intention is to mitigate that through price increases.” —Electrolux (Appliances)

Travel to Europe slowed late in the summer

“International inbound volumes in Europe softened significantly as the summer progressed. Industry fleet levels turned out to be loose relative to demand in August and September, and pricing was negatively impacted. Whether this was due to security concerns, Brexit, the Olympics, the economy or some combination of these items, it’s hard to tell.” —Avis (Rental Cars)

A few companies highlighted China as an area of strength

“Hugo Boss continues to operate in a challenging market environment. In Europe, in particular, trends in the premium apparel industry continued to soften. The US market remained under pressure and highly promotional. And while the Chinese mainland has started recovering somewhat, other Asian markets still face considerable challenges industrywide.” —Hugo Boss (Apparel)

“Yeah, we too have seen the strength that other companies have talked about in China. We had a pretty strong Q3 overall in terms of our order bookings in China and we saw that in our Hydraulics business. We saw that in our Electrical business as well. So certainly, the government stimulus programs are helping. Their monetary policy is helping. Whether or not these structural improvements will continue into the future, I think it’s once again another one of these points of uncertainty. And they put the stimulus programs in effect for a reason. So they had some underlying concerns. But at this point we think China has certainly stabilized.” —Eaton (Industrial)

Financials:

Companies are masking slow growth with acquisitions

“So if this thing keeps going and gets sloppy, then we’re going to have to add to our acquisition pool…to feed our chance to reposition and restructure and derive top-line growth through acquisitions, because the core economic growth we do not see coming through for the next couple of years.” —Emerson Electric (Industrial)

Commercial real estate never fully priced in low interest rates

“As rates rise, obviously, cap rates will sneak up but the drop in rates was not fully passed through on cap rates. In other words, a spread over base rates came up. So as rates rise, some of that will be absorbed we think by a return to more normal spreads.” —Blackstone (Asset Management)

Cap rates could still compress further

“we haven’t seen cap rates back up in any of our markets, if anything we’ve seen added cap rate compression, because of what’s going on now there are good number of assets that are being bought by companies that…in their host countries they can borrow at 1% and then get a 3.5% coupon on the lease transaction or the sale transactions that they buy and that’s a massive spread. So if anything for great stuff, I think cap rates could compress further” —Kilroy (REIT)

Asian investors don’t have a problem with Brexit or low rates

“From a continental European perspective, there’s tremendous concern around what will happen to the UK…The further you move away from the UK, and particularly to Asia, the Chinese, the Malaysians, the Indonesians who have been investing heavily in the UK, they are not too concerned about the UK breaking away from the EU. So their interest is still very, very strong, and I would put the Americas somewhere in the middle of the two with regards to their interest.” —Jones Lang LaSalle (Commercial Broker)

Venture Capital valuations have come down

“We’re seeing valuations in venture come down. We’re seeing that the next round of equity capital, which is typically our take-out, take longer. So I think that business is a little bit choppier. We’ve added a non-accrual or two over the course of the year. And I think that’s representative…I think venture is going through a time where you need to be more cautious and be paying attention to the fact that valuations are coming down and capital isn’t flowing quite the way it was maybe 12 months ago.” —Ares Capital (Business Development co)

Consumer:

Only 22% of NY Times’ revenue comes from print advertising

“Print advertising is a much smaller part of our business today than it once was, accounting for just 22% of total revenue in the quarter.” —NY Times (Newspaper)

Facebook revenue growth is going to slow

“we do expect that as you get to mid-2017, ad load will be a less significant factor contributing…I do think that as we slow ad load growth, we’re going to have a slowing in revenue as well. So that’s our expectation” —Facebook (Social Media)

Alibaba wants to help retailers online and offline

“The most important opportunity on horizon is helping traditional business to upgrade into a new retail model and not continuing to grow online business in isolation. Online and offline will be a single seamless experience, not just in consumer interaction, but also in the entire business operation and execution.” —Alibaba (China e-commerce)

Technology:

Amazon is stepping up its investment pace

“The investment that we are seeing is a step-up versus what we have experienced in particularly the first half of this year and the last half, the second half of last year which I mentioned. But we have said investments are going to be lumpy. They are going to be high sometimes and they’ll be moderated at other times. We are right now, the second half of this year looks like a big step-up compared to the first half and it is.” —Amazon (Ecommerce)

No one has digital security figured out

“anybody who will tell you that they figured it out of safety and security. It’s probably somebody you should run a mile from, because there is no such right answer. There is a continuous effort of people break into everyone systems. You read that all the time.” —Mastercard (Payments)

Healthcare:

Branded pharmaceutical pricing power has softened

“[pricing] softness became much more pronounced in our second quarter, first around brand inflation and later, around customer pricing.” —McKesson (Pharma Distributor)

Doctors’ offices are consolidating

“there has been tremendous change. I think, as everybody’s aware in just sort of how healthcare is being delivered, the smaller practices, the two, three, four doctors, they’ve been forming bigger practices, been joining hospital groups, so the landscape has changed.”–Markel (Insurance)

Industrials:

25-30% of cars may be electrified by 2025

“at the Paris Auto Show, vehicle electrification was front and center, as customers look to close regulatory gaps on CO2 emissions and improve fuel economy. Industry experts and even some of our customers are now forecasting 25% to 30% of vehicles to be electrified by 2025” —Delphi (Auto Parts)

Materials, Energy:

OPEC is producing oil at near its maximum levels

“The 2.2 million barrel per day decline in non-OPEC production since 2014 has been fully offset by rising OPEC production which achieved record levels this summer along with Russian production which achieved record levels in September. Overall, we believe OPEC to be producing at near maximum levels with little remaining excess capacity cushion which has delayed the inevitable rebalancing of the world oil markets.” —National Oilwell Varco (Oil Service)

It’s still not worth investing in natural gas

“Well you know, I’ve been a natural gas bear for quite a while. I think we always thought that gas would find its way up around $3 and it would find a ceiling there. And to a large extent, that’s been correct. I mean we’ve always believed around $3, that there was just an impediment from a demand standpoint for now…I think our view is that it would take natural gas to approach $6 before it would probably displace our interest investing in oil. And I don’t see that happening.” —Anadarko (Oil and Gas)

The race to the bottom in iron ore prices is over

” In the third quarter, we witnessed some remarkable stability in iron ore pricing with the index trading within a tight range for the entire quarter. Once again, the analysts who predicted that iron ore prices would fall off a cliff were wrong. Wrong again. As I always say, iron ore is not your typical commodity as the vast majority of the supply is controlled by a small number of producers. For some time, iron ore prices were going down because a few executives in positions of power with the major iron ore producers were working very hard to drive these iron ore prices down. However, after the Boards of Directors of the Australian producers took action and all but one of these executives were let go from their respective jobs, these companies under new management are now generating better margins and more decent returns for their shareholders. No more race to the bottom. The Australian-Brazilian championship of stupidity is over. Check the box.” —Cliff’s Natural Resources (Iron Ore)

Miscellaneous Nuggets of Wisdom:

A company built through acquisition looks different from one built from scratch

“we built this company for the most part through a series of acquisitions. And when you acquire companies, you always acquire excess capacity in manufacturing. And if you’d said, do you have the ideal footprint, if you could start from a clean sheet of paper and redraw it, you never end up in that place if you grow a company through acquisition.” —Eaton (Industrial)

More isn’t better, only better is better

“When you then migrate over to original programming, I’ve said this before, it’s absolutely true, more isn’t better, only better is better. We’re not trying to just spend money. We’re trying to spend money thoughtfully to differentiate high-quality programming and build more consumers and build more addicts across our subscriber base.” —Time Warner (Media)

“So in terms of scale, look I think as we’ve often said, this is an industry and a business that thrives on scale. But at the same time, scale for scale sake is you know are not something that we think should be pursued.” —21st Century Fox (Media)

Don’t fear your opponent, make your opponent fear you

“It makes me remember a famous quote from the Civil War when Ulysses S. Grant took over the Union Army. He was always getting criticized. He was always hearing from his generals about what Robert E. Lee was going to do. Robert E. Lee is doing this. What are you going to do about that? And one day Grant said, you know, I’m so sick and tired of hearing what Lee is going to do. Well, Lee needs to worry about what we’re going to do. And I think that’s how I feel about our competitors. They need to worry about what Whole Foods is going to do.” —Whole Foods (Grocery)

Don’t be bullish with other people’s money

“All right. So just one thing. I’m not bullish. You can be bullish. I can’t. Because if I’m bullish and I’m wrong, we are going to hurt a lot of people, a lot of investors. A lot of money will be lost, money that’s mine, money that’s not mine, from my investors. So I’m never bullish. I’m always very, very, very protective over our thing. That’s the reason we have been so successful because I play with a lot of caution – with a lot of cushion in our forecasts.” —Cliff’s Natural Resources (Iron Ore)